As people across the globe are becoming health-conscious, one of the largest food chains across the world has the reputation of serving cheap and unhealthy food. Yes, I am talking about McDonald’s (NYSE:MCD), which recently hosted a dinner for reporters and bloggers wherein waiters served cuisine prepared by celebrity chefs using ingredients from the chain’s menu. Basically, this event was organized with the intent of transforming McDonald’s dining experience from just “fast food” to “good food served fast.” After reporting lacklustre second-quarter earnings, the food giant is attempting hard to build a sturdy image in order to sustain momentum in a fiercely competitive industry.

A brand makeover in process?

McDonald's reported flat comparable store sales globally in the second quarter earnings. Average check was higher, but guest traffic was negative in all major markets. Store expansion led to revenue growth of 1%, but operating income was flat, and EPS was up 1% driven by share repurchases.

U.S. comparable store sales were down 1.5% with operating income up 1%. In Europe, comps were down 1% and operating income was flat. In the APMEA (APAC, Middle East and Africa) region, comps increased only 1.1% and were weighed down by weakness in Japan. Operating income declined 2%.

The comps numbers clearly indicate that McDonald’s is struggling to find new customers as well as retain existing customers because of the deteriorating brand image. However, in my opinion, analysts and investors have been a little harsh on the company. Consider this: McDonald’s took no time to withdraw all products manufactured by its Chinese distributor, Shanghai Husi Foods that was in the news for selling expired meat and chicken to the company’s outlets in China. The move helps McDonald's protect itself from future quality issues from China and to minimize this impact on future relations with both China and global customers.

Topline sustainability is important

Unarguably, McDonald's has been a dividend darling and data shows that the dividends given out by the company have grown at a compounded annual growth rate (CAGR) of 20%. One of the reasons that McDonald’s has been a generous dividend payer is that it has been able to sustain its considerably high margins. In the fiscal year 2014, McDonald's had an operating margin of 18.6% and out of its net income 30.7% was paid as dividends to the shareholders. Whereas in the fiscal year 2013, McDonald's had an operating margin of 31.2% and 56.2% of the net income was given out as dividends.

However, the main cause of concern is that McDonald’s is struggling with maintaining a stable earnings growth. As such, it is a possible scenario that it may not be feasible for the company to keep up the current dividend yield of 3.45%. In a way, it’s a connected cycle of events because if McDonald’s is not able to expand its top line, then the earnings will take a beating and the recent store numbers highlight a not-so-good scenario for the company’s revenue numbers in the future.

What lies in the future?

Since the beginning of this article, I have highlighted the significant issues that brand McDonald’s has been facing in the last few quarters. The downbeat numbers are nothing but a consequence of a falling brand image. The best way to pull out of this crisis is to take solid steps to improve the perception towards the products offered by the company. I believe that the recent steps taken by McDonald’s are in the right direction, and it has the capability to sail through the rough patch.

They have handled these situations through innovations in the menu, improvements in the food quality and innovative big-scale marketing campaigns. McDonald's has a strong-brand image, and it benefits from convenient restaurant locations. It is also helped by its unparalleled advertising and bargaining scale and by its organized franchise system which operates worldwide.

About the author:

Riddhi Kharkia

A practicing Chartered Accountant based out of India. I have keen interest in analyzing tech stocks that are driven by value.

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